Sunday, December 21, 2014

The Worst Price and Long-Term Bargains

Professional investors and their political economies are very much interested in the price discovery functions of the securities and commodity markets. Prices translate into performance. Unfortunately, past performance leads to future individual investment decisions and asset allocations. In viewing the results for any given year, the last or terminal price plays an important role in the calculation of the resulting performance. Thus the December 31st (and to a much lesser extent June 30th) prices play a disproportionate role in the calculation that produces rankings, bonuses and job longevity. (Our actuarial friends would prefer multiple-date averaging calculations to “Last Trade on Last Day” as a better representative to what was happening.)

For 2014 in particular, I suspect the quality of the last prices will be weak. Due to restrictions as to the size and deployment of capital on various trading desks, the normal capital absorption capacity will be limited. Further, many organizations have already determined the size of gains and losses that they wish to sustain for the year. Thus there will be less buying power available on the last trading day of the year. Remember, the absolute final price on the last increment of trading will determine performance. In some prior years we saw a concerted effort on the part of performance players to ramp up prices of what they held in the last hour of trading. In some extreme cases there were efforts through short sales and other techniques to lower important prices for securities owned by specific competitors.

Ahead to December 31, 2014

At the moment I expect a slow Year-end day, but I am prepared for a spike in either direction on the last day which could be well reversed on the first trading day of 2015. In a relatively dull performance year the level of distortion is likely to be 1% or under.  From a performance analysis viewpoint I will pay more attention to year-to-date performance through November and/or the latest twelve month performance through the end of January, 2015. These mathematical machinations have some value in managing portfolios that have limited duration found in operational and some shorter-term replenishment portfolios. It should have no impact on decisions for endowment and legacy portfolios.  These refer to our Timespan L Portfolios™, which are segmented by investment period focus.

Better performance warnings

After a week when some of our holdings from bottom to top gained 5%+, for example T Rowe Price*, I start to get nervous about rising volume sucking in sidelined cash. (NASDAQ OMX* stock volume almost tripled from 773,829 shares to 2,225,599 shares in two days.)  These reactions need to be put into perspective. My old firm, now known as Lipper Inc., produces a daily index for each of 30 equity investment objectives. The components of these indices in the more numerous groups are the thirty largest funds.  In the smaller groups the number of components can be as small as ten. Examining the performance roster I noticed the Large-caps were up 10%, Multi-caps 9-10%, Mid-caps slightly under 8%, and the Small-caps 1.7%. What this suggests to me is that in a period of declining liquidity, institutional investors continued their Large-cap affection. Small-caps were the best performing investment objective asset based group in 2013, demonstrating their recovery potential.

The first warning in terms of a possible blow off will be when Small-caps become once again performance leaders and the investing public throws an extra $100 billion+ into Small caps which can happen.

The second warning is excessive focus on market capitalization as a screen for choosing investments. I note that on a five year compound annual growth rate basis there is little to separate the different investment objective groups’ performance; the entire range for these indices was a low of 13.92% for Large-cap Value, to a high of 15.77% for Multi-cap Growth funds. This narrow performance spread reminds me of one of the phrases that I learned at New York racetracks: one could throw a blanket over the leading horses at a heated finish line. In other words, even with all the traditional handicapping skills, the results of close races can not be successfully predicted. I would suggest that if in the future we have another five year like the last, investors should be pleased to be under the blanket of a 13.92% to 15.77% performance range, and not try too hard to pick the single best winner.

Target Date funds may not be optimal

There is another factor that may change the level of flows going into equities. The most popular inclusion in many 401(k) and similar plans are Target Date funds. The plans that are adopting these relatively new vehicles would be doing their beneficiaries a favor if they instead had chosen the mutual fund industry’s original product which was the Balanced fund where the managers made investment allocations between stocks, bonds and cash based on their outlook.

Lipper Inc. has 12 indices of Target Date funds broken down largely by maturity or retirement dates with performance on a year-to-date basis of +4 to +5%. None of them has done as well as the Lipper Balanced Fund Index gain of +7.03%. In the right hands, most potential retirees would be better off in a Balanced fund. Often the better performance of a Balanced fund is due to its investment into reasonably high quality equities.

Benefiting from discontinuous forecasting

I have often said that I can and want to learn from smart people, thus I read Howard Marks’s letters. Howard is the very smart Chairman of Oaktree Capital and an old friend. He devoted his latest insightful letter to what can be learned from the current decline in the price of oil. He focuses on the failure of most forecasts of the price of oil. These failures created what Wall Street Journal columnist Jason Zweig has called the “Petro Panic” which dropped stock and bond markets globally. Howard focused on the fact that oil price predictions were extrapolations of the past, adjusted perhaps by plus or minus 20%. This is similar to most predictions coming out of the financial community. I would suggest that these are not really helpful on two grounds. Most often the impact of the forecast is already in the price of the stock or bond in question. In addition, big money is only earned or lost when the old model is disrupted.

Three long-term items on my screen

In our Time Span Portfolios approaches, the final portfolio which is the Legacy Portfolio is expected to include securities from various successful disruptors. While there is a place at the right time and price for investing in secular growers, they are not usually the sources of extraordinary gains. These are what I like to find. I do not have the same scientific background as many of my fellow Caltech Trustees; therefore it is unlikely that I will invest client money on the basis of what is in a laboratory. I need to enter into the process later when my reading and some of my contacts can guide me in the right direction. Let me share three examples that I am looking into:

1.  The first is the global shortage of retirement vehicles. Almost no nation has sufficient retirement capital in private hands to meet the increasing retirement needs of large portions of its population. Europe is particularly troubled or should be with more people going into retirement, living longer, and fewer competent workers. I believe some of these needs can and hopefully will be met by mutual funds sold wisely to the public. Two of the investments in our financial services private fund portfolio address these needs. Both Franklin Resources* and Invesco* have strong retail and institutional distribution in Europe as well as in Asia. Their current stock prices are based on the perceived value of their present business and are paying little to nothing for their potential. At some point I believe either or both will show more earnings power internationally than domestically.
*Securities held personally and/or by the private financial services fund I manage

2.  The second item is one that I have only a tiny direct exposure; it is an expected exponential growth in the service sector within China and some of its neighbors.

3.  The third potential actually ties back to the concerns created by the Petro Panic that is the announced long-term strategy of Toyota to get rid of gasoline cars. I am trying to determine what else will be needed as people change their driving habits.
Question of the Week: Please share how far out are you looking and what are you seeing?
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Sunday, December 14, 2014

‘Tis the Season to Make Buy Lists


The shopping malls’ parking locations are increasingly crowded as shoppers are busy executing their Christmas and Chanukah gift lists being spurred on by the new discount levels of more than 50%. The shoppers look to be pleased with their purchases.

Perhaps my coincidence in the investment world which regularly rotates to being ahead or behind the world of retail sentiment,  recognizes this past week should call all serious investors to begin their research lists to examine the discounts from the peak stock price levels being offered to them. Please note I said research lists not an axiomatic buy list. There can be some long-term concerns that make current discounts not yet attractive.

This is an old exercise for me. As an analyst whenever there was a meaningful decline in the market I would make lists of stocks with future attractive price levels. The problem with these lists was that largely the stocks did not fall to really cheap prices, the equivalent to 60%+ discounts at the mall. Thus for all of my analytical skills, usually I did not execute as many buy orders as I should have. What I learned and now recommend is that instead of single price activators, one should develop a set of steps of declining prices combined with increasing levels of purchases. Buying more at cheaper prices is good as long as the declines are not in response to long-term changes in outlooks. The late and great Sir John Templeton and his chief investment officer Tom Hansberger made considerable fortunes for their clients always looking for better bargains than what was generally “on offer” in the market.

Some large and small examples:

The current apparent concern of the general stock and bond market is that the willingness to maintain supply levels of petroleum in the face of cyclical economic declines in Europe, Japan, and China is leading to lower trading prices for petroleum. I see little in the way of evidence of the relationship between the use of energy and a change in long-term economic growth. As a matter of fact, to the extent that energy prices remain low, the conservation efforts are likely to be reversed and we will probably become inefficient in our use of “low cost” energy.

I am addicted to being a long-term investor; I do not have the trading skills that others seem to possess. With that thought in mind, for an account with more than ample cash reserves held by an investment group of present and recently retired investment professionals, I recommended that the energy component be raised from 7% to 10%. In our energy basket we include various up, mid, and down stream petroleum and alternative fuel sources, rail tank car producers, railroads and various energy services suppliers. I am reasonably confident if the group averages down and holds for a long-term, the results will be pleasing. One of the smarter, large, (actually very large) investors today is Steve Schwarzman of Blackstone. He is now launching a multi-Billion dollar Energy Fund. He remembers when it was cheaper to find oil on the floor of the New York Stock Exchange than to drill for it. We are probably not there yet, but we are already seeing foreign buyers nosing around Canadian and US companies.

Mutual funds

Turning to an arena that I spend most of my waking time on, I believe there is a great trade opportunity presently. The year-to-date average performance of 24 commodity energy funds through last Thursday was down -25.99%. On the other hand the average for 88 Health/Biotech Funds for the same period was up +27.96%. (Friday was a bad day.) While we have benefited nicely from over-sized positions of Health/Biotech stocks in general diversified funds, I suspect that an energy-oriented portfolio will have better performance over the next two years than one heavily invested in Health/Biotech stocks.

In terms of my Time Span Fund Portfolios, this decision was for the operational time span portfolio (1-2 year duration) and the replenishment portfolio (up to five year duration), but not for the endowment portfolio (ten or more years) and certainly not for the legacy portfolio (for the benefit of future generations). For the longer term portfolios I recommended that at least one of the members of their investment steering committee have a background in commodities. I am not so bold as to suggest that commodity-oriented investments should be included today. I would want the committee to be aware of future commodity price moves. Rising commodity prices will affect food, transportation, manufacturing, energy, and financial services thus can be very important to most stock and bond portfolios.

Financial services

One of my lenses through which I examine the stock market is the holdings in the private financial services fund that I manage. Some of these stocks have been falling since the beginning of the current year after a generally good 2013. Others may have temporarily peaked in early December. In December through Friday, Moody’s* broke down from its $100 handle and now is down -7.46%. I perceive no change in the incredible need for income that is driving the issuance of more bonds and other financial instruments. However, the gain in the share price for the calendar year through the end of November was well over 20%.

A possible explanation

All stocks, particularly those with outsized gains, are subject to the practice of wealthy investors giving significantly appreciated shares to charitable organizations who immediately convert the gift to cash. This could be a possible explanation. Let me give a particular example of the stock price of T Rowe Price*. On Monday of last week on slightly under 900,000 shares being traded, the stock hit a high price of $85.45 closing at $84.80. At the end of the week on a pressured Friday the daily volume doubled to 2 million shares with a closing price of $82 near its low for the week of $81.97.
 *Shares held personally or in the private financial services fund I manage.

Longer term outlook

I was hoping to begin this week’s post with a headline “The Bad News is the Stock Market is Rising.” The reason for this contradictory thought was based on my often-expressed fear that growing enthusiasm was leading to a speculative, parabolic stock price rise; one of the remaining missing elements to be able to declare a major top. Luckily for all of us that this week’s decline activated a pressure release valve in the beginning to boil market. I should not have worried according to David Kotok the leader of Cumberland Advisors. In his December 12th commentary he noted the reactions to his talks with the analyst societies in Providence and Boston. He asked whether 18000 on the Dow Jones Industrial Average would be the break point and whether they thought that the closing one year from the day of his talk would be higher or lower. Almost half thought lower. That view was pleasing to him as he is fully invested in ETFs. I am also relieved because without the “professionals” leading or trying to get caught up with the charge, my feared final stage won’t happen. However, I am keeping my eye on the difference between redemptions of equity mutual funds and the purchases of stock Exchange Traded Funds. What I don’t know now is how much of the ETF purchases are from sharp investors like Cumberland or how much of the purchases are from approved participants that are buying shares of ETFs to facilitate their customers shorting these ETFs (either as a hedge versus their other holdings or expressing a view on future prices). Bottom line: many are confused about the outlook for the market. As a “registered contrarian” I am reasonably assured and only become deeply concerned when all of the market passengers move to one side of the boat.

Please share with me any evidence that you now have for materially changing your long-term views on stock and bond prices.
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Sunday, December 7, 2014

Current Investments for Future Results


In our job as professional investors for others as well as personal stewards for ourselves and families we do something today that we want to have a good result in the future. This is easier said than done. To accomplish our goals we need to answer at least two basic questions: 

What are we doing?  Which future?

To help answer these questions, we should be asking ourselves on which time period are we focusing. We have created at least four time spans to put the answers into perspective. These four slices go from:

1. The immediate as defined as the next two years,
2. The following five years to replenish spent capital,
3. The succeeding ten or more years to address longer-term needs for the current decision makers, (endowment issues) and
4. Future periods to aid fulfilling the legacy of the grantor and his/her succeeding generations.

This weekend I seek to apply the items that cross my information screens to appropriate investment time spans.

The current period

To meet current and near-term needs we assume that we can convert our present investments to cash for either spending or repositioning. Too many investors look entirely to current prices and economic conditions. As someone who has grown up in the investment business, I am concerned that the changing structure of the marketplace is not being considered. What I add to my decision process (and what is missing from many strategies today) is a focus on liquidity.

The real price

Portfolio managers and analysts can learn a lot from professional traders. Traders will tell you that a stock or a bond is worth only what it can be sold for. Far too many investors use the last published price without understanding the conditions that led to the price in terms of the relative balance of supply and demand. Quite possibly because of changes of capital on trading desks or floor participants the last published price is quite stale. This is particularly true if you are a potential seller with an over-sized position. A current example of this is the recent drop of 6% in three minutes for shares of Apple*. According to some, the sudden drop was caused by one or more major players that used algorithms to significantly reduce over-sized positions in tech stocks.

Investment committees have regularly received reports on what specific days to liquidate positions based on average historic volume. Traditionally these reports are meant to show how quickly cash can be raised. Sole reliance on these reports is dangerous. First, liquidity is very much a function of the current desire for the security. Second, increasingly more volume is transacted off the floor than on it and there is no real floor for bonds thus the published volume figures are more an artifact than accurate. I wonder when looking at liquidity whether one should follow the dictum of US Supreme Court Justice Potter Stewart in ruling as to what was pornographic or not: he said he would recognize it when he saw it. To reinforce my skeptics’ view on liquidity let me use the extreme performance of Precious Metals mutual funds as an example.

In the week ended on December 4th the average Precious Metals fund was off -4.66%, the worst of the 30 equity funds groups tracked. However in just four weeks including the December 4th period, the average Precious Metal fund was up +10.47% which was the best of the equity fund averages. I would suggest that the fundamentals did not change that much in those four weeks, but the market did.

Another example that attitude changes greater than fundamental changes is the price and volume in the week for the stock of T Rowe Price*. On December 1st it closed at $82.61 on reported volume of 753,104 shares. On December 5th the closing price was $84.49, down slightly from its day high of $84.88 on 1,105,152 shares.

One of the Republican SEC commissioners has expressed concern about the liquidity in the bond market when interest rates start to gyrate. I believe her concerns are well placed.

The focus on liquidity is of particular importance when investing for current returns in the first or operational time span portfolio. If due to spending requirements, securities will need to be cashed-in at the same time as liquidity shrinks, the quicker the near-term portfolio will be exhausted and need to be restored by the replenishment portfolio.

Replenishment portfolio

A well thought-out piece by Marcus Brookes of Schroders Investment Management begins with the following sentence. “We end 2014 with almost every asset class offering investors scant potential return for their risk.” In looking how to build a successful replenishment portfolio I suspect that at some point over the next five years the need to earn a real return adjusted for credit risk will become apparent through a market decline. Having issued this warning, it does not relieve investors of the need to build and manage a replenishment portfolio. While many investors talk long-term they walk short-term by managing their investment against a one to five year time horizon. Under those constraints there is little room for long-term bonds or stocks that are dependent upon substantial new products or massive turn arounds.

While it increasingly looks like we may get a bout of enthusiasm, one would be wise to upgrade the quality in the replenishment portfolios even though during a speculative phase they will probably under-perform, but they will sink less when the eventual significant decline occurs. Moody’s* is recognizing that “corporate credit has become more risk averse, while the common equity market has become more tolerant.” Surviving investors normally bet with the fixed-income markets, while the traders with the stock market. Both can be correct using their preferred time periods of five and ten years for the investor and quarter, half, and full year for the trader. 
*Owned by me personally and/or by the financial services fund I manage

Legacy investing

Very long-term portfolios are often a mix of companies that benefit from sustainable demand based on demographic and geographic changes as well as disruptive companies. This somewhat hedged mix assumes that there will be evolutionary changes as well as revolutionary changes ahead. The first group of investments should provide sustainable income and capital growth until their mistakes or the disruptions created by the second group of companies hurts them. The failure rate of the second group will be high as they will lack the management skills needed to leverage their disruptive power. The first group will have fewer failures but they will be more painful with less chance for full recovery.

The 85 most disruptive ideas since 1929 were recently published by Bloomberg Business Week in celebrating its 85th birthday.  One could probably devote an entire business school education trying to understand the power of the 85 disruptive ideas and how few of their inventors or developers produced lasting fortunes. The first three are good examples of the tenet that early inventors and early investors don’t get the major benefit of their disruptive talents. The three are the Jet Engine, the Microchip, and the Green Revolution.

We do not invest in Venture Capital funds to participate in the invention of products and services. Sometimes Private Equity is the way to go as developers build out to an eventual exit strategy. We prefer to use mutual funds which invest in the users of the disruptive forces unleashed in a way that can be leveraged to the benefit of both customers and shareholders.


Pick your time period for judging investment success and that should direct the composition of your portfolio. If you need help, email me.
Comment or email me a question to .

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Copyright © 2008 - 2014
A. Michael Lipper, C.F.A.,
All Rights Reserved.
Contact author for limited redistribution permission.